Journal of Air Transport Management 8 (2002) 365–372
Incentive-based regulation of CO2 emissions from international
aviation$
Fredrik Carlsson*, Henrik Hammar
Department of Economics, Gothenburg University, Box 640, SE-405 30 Gothenburg, Sweden
Abstract
We explore the possibilities of using incentive-based environmental regulations of CO2 emissions from international civil aviation.
In theory incentive-based instruments such as an emission charge or a tradable emission permit system are better regulations than
so-called command-and-control regulations such as emission limits or technology standards. However, the implementation of these
instruments is a complex issue. We therefore describe and discuss how an emission charge and a tradable emission permit system for
international aviation should be designed in order to improve efficiency. We also compare these two types of regulations. In brief, we
find that an emission charge and a tradable emission permit system in which the permits are auctioned have more or less the same
characteristics. The main advantage of a tradable emission permit system is that the effect, in terms of emission reductions, is
known. On the other hand, we show that under uncertainty an emission charge is preferred. The choice of regulation is a political
decision and it does not seem likely that an environmental charge or a tradable emission permit system would be implemented
without consideration of the costs of the regulation. Revenue-neutral charges or gratis distribution of permits would, for this reason,
be realistic choices of regulations. However, such actions are likely to result in less stringent regulations and other negative welfare
effects. r 2002 Elsevier Science Ltd. All rights reserved.
Keywords: Greenhouse gases; Environmental regulation; International aviation; Carbon charge; Tradable emission permits
1. Introduction
There has been increasing concern over the environmental impacts of civil aviation due to an expected
increase in international air traffic and an increased
awareness of environmental problems such as global
warming and noise pollution. Traditionally, environmental regulations in the aviation sector have been
command-and-control (CAC) regulations such as engine
standards and restrictions on flight movements. In
recent years there has been an increasing interest in
incentive-based (IB) environmental regulations such as
fuel charges, emission charges and tradable emission
permits (TEP). The European Union (EU) Green and
$
(
We have benefited from discussions with Francisco Alpizar, Asa
.
Lofgren
and Olof Johansson-Stenman and we also thank the editor
and an anonymous referee for useful comments Financial support
from the Swedish Civil Aviation Administration and VINNOVA is
gratefully acknowledged. This is a revised version of a paper presented
at The New Regulation in the Transport Sector: Rules and Instruments,
conference in Trieste, September, 2001.
*Corresponding author. Tel.: +46-31-7734174; fax: +46-317731043.
E-mail address: [email protected] (F. Carlsson).
White Papers on pricing in transport (European Union,
1996, 1998) recommend IB environmental regulation of
the transport sector. In Sweden, for example, landing
charges are now not only based on noise pollution but
also on emissions of nitrogen oxides (NOx) and
hydrocarbons (VOC) during landing and take-off. A
number of recent papers also discuss IB environmental
regulation of the aviation sector, see for example
Alamdari and Brewer (1994), Carlsson (1999) and
Schipper et al. (2001). In this paper we explore the
possibilities of using IB environmental regulation of
carbon dioxide (CO2) emissions from aviation, with a
particular focus on international aviation. Regulation of
CO2 emissions raises intricate policy issues due to their
global nature.
2. Background
2.1. CO2 emissions from aviation
The impact of aviation emissions on climate and
atmospheric ozone has recently been investigated by the
0969-6997/02/$ - see front matter r 2002 Elsevier Science Ltd. All rights reserved.
PII: S 0 9 6 9 - 6 9 9 7 ( 0 2 ) 0 0 0 1 1 - X
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F. Carlsson, H. Hammar / Journal of Air Transport Management 8 (2002) 365–372
Intergovernmental Panel on Climate Change (IPCC).
Emissions from aviation have an impact on the
atmospheric composition and estimated to represent
approximately 3.5 percent of the total radiative forcing
from human activities.1 The IPCC predicts an annual
increase in aviation fuel use of 3% between 1990
and 2015, they also present a number of scenarios
in which the annual growth of fuel use is between
0.8% and 2.8% for the period 1990–2050 (Intergovernmental Panel on Climate Change, International Civil
Aviation Organization, 1999). Consequently, we can
expect that emissions from the aviation sector will
increase in the near future, and if no further regulations
are introduced the increase will most likely be large.
According to the IPCC, these emissions, together
with emissions from other sectors, have a significant
impact on the global climate, and a reduction of
the emissions is necessary if we wish to decrease the
probability of an anthropocentric induced climate
change.2
2.3. The Kyoto protocol and international aviation
Only emissions from domestic aviation are considered
national emission in the Kyoto Protocol. Instead, the
Kyoto Protocol delegates the responsibility for international aviation emissions to the International Civil
Aviation Organization (ICAO). International aviation
treaties have been obstructing environmental charges,
and there are still obstacles for implementation of, for
example, a fuel tax. The Chicago Convention prohibits
taxation of fuel in transit, and many bilateral Air Service
Agreements prohibit taxation of fuel. However, in 1996
the ICAO adopted a resolution allowing individual
countries to implement environmental charges (International Civil Aviation Organization, 1996). In the
resolution, ICAO recommends that any IB regulation
should be in the form of charges, and not taxes.3
Furthermore, there should not be any fiscal motives
behind the charge; it should be related to costs, it should
not discriminate against air transport and the raised
funds should be used to mitigate the negative environmental impact of emissions.
2.2. Sources of emission reductions
There are essentially two types of aviation emission
reductions: (i) a reduction in the number of flights and
(ii) a reduction in emissions per flight. A reduction in the
number of flights can be attained by a sufficient
reduction in the number of passengers, increased seat
capacity and/or increased load factors. The amount of
CO2 emissions depends on the carbon content of the fuel
type, but on average 3.16 kg CO2 are emitted per kg fuel
burned. Increased fuel efficiency may on one hand
decrease emissions of CO2 and HC, but may on the
other hand increase emissions of NOx, since higher
engine temperatures tend to increase emission of NOx.
These potential negative side effects make it unrealistic
that only CO2 emission would be regulated. Other
factors, such as improvements in the Air Traffic
Management (ATM) system, including improvements
in communications, navigation and surveillance (CNS)
systems can result in a 6–9% reduction of global CO2
emissions by 2010 (Intergovernmental Panel on Climate
Change, International Civil Aviation Organization,
1999). A survey by the International Air Transport
Association also indicates that improvements of CNS/
ATM systems are sources for improvements in fuel
efficiency; in the US and Europe a 5% reduction of CO2
emissions by 2015 is possible (Dobbie and Eran-Tasker,
2001).
1
Radiative forcing is a measure of the importance of a potential
climate change mechanism, and expresses the change to the energy
balance of the atmosphere, i.e. its potential effects on climate change.
2
It should be noted that other researchers are skeptical about both
the evidence on global warming and the role of man-made emissions,
see for example Michaels and Balling (2000).
3. Incentive-based instruments for international aviation
3.1. Overview of incentive-based instruments
In theory, IB instruments such as an emission charge
or a tradable emission permit system minimizes the total
cost of reaching a given level of emission reductions,
since each firm reduces its emission until the marginal
cost of reduction is equal to the marginal tax or the
permit price. Since marginal abatement costs in many
instances are heterogeneous and unobserved or costly to
observe for the regulator, a CAC regulation in terms of
emission limits is less likely to reach a certain level of
emission reductions at the same cost (Baumol and
Oates, 1988). A comparison of costs among different
regulations depends on several factors. Still, the
empirical evidence suggests that the costs savings can
be large. Tietenberg (1990) compares different regulations of air-pollution to a least-cost instrument, and
finds that the costs vary by a factor of 1–22. Compared
to CAC regulations, these instruments also provide
higher incentives for adoption and diffusion of cleaner
technology (Milliman and Prince, 1989). The reason is
that cost savings are larger for IB instruments, since
3
Some argue that there is a fundamental difference between a tax
and charge, and that the purpose of a tax is to generate income to the
regulator (e.g. Mendes de Leon and Mirmina, 1997). However, even if
the revenues from the regulation are not recycled to the airlines or the
airports, the purpose of the regulation can still be to reduce the
environmental problem. Although it should be granted that a regulator
could use the environment as a scapegoat for increasing taxes for
generating revenues.
F. Carlsson, H. Hammar / Journal of Air Transport Management 8 (2002) 365–372
reduced emissions also reduce direct costs of the
regulation.
Although emission taxes are becoming more common
in developed countries, only six countries have implemented environmental taxes based on the carbon
content of energy products, and some countries have
energy taxes that do not consider the carbon content at
all (Baranzini et al., 2000). In 1990, the cap-and-trade
program for sulfur dioxide (SO2) emissions from electric
utilities was introduced in the United States. The first
phase of the program was initiated in 1995, and the
second began in the year 2000. The program first
establishes an aggregated emission limit. Then the
emission limits (caps) are distributed at no cost to firms,
mostly according to historical emissions and volume of
fuel use. This type of system where the permits are
initially distributed gratis is called a grandfathering
system. A small number of permits are also auctioned
annually by the Environmental Protection Agency
(EPA). The individual sources are allowed to trade the
permits with any party, or to bank them for later use.
The implementation of the cap-and-trade program has
in many respects been a success (see e.g. Ellerman et al.,
1999; Burtraw, 1999). It has also resulted in a number of
important lessons on how to design a program of
tradable emissions permits (see e.g. Stavins, 1998).
3.2. An aviation tradable emission permit system
The Kyoto Protocol only involves domestic aviation
and the responsibility for international aviation has been
delegated to the ICAO. Tsai and Petsonk (2000, p. 786)
reasonably define international aviation to cover ‘‘civil
transport between one nation and any place outside that
nation’’. If two or more countries form a ‘‘bubble’’ it
seems likely that the baseline emission would include
emissions from flights between the countries within the
agreement (Tsai and Petsonk, 2000).4 Consequently, we
have to distinguish between a TEP scheme for international aviation emissions and one for domestic aviation.
According to Tsai and Petsonk, customary international
law implies that all flights between two nations where at
least one is an Annex 1 party would be covered in an
international TEP. In addition, any flight involving an
Annex 1 carrier would also be covered by the system.
As argued by, for example, Zhang and Nentjes (1999),
there is much to gain from allowing inter-source trading,
compared to inter-government trade. The reason is that
individual sources have better information about their
abatement costs, and trade between individual sources
in different sectors can lower total abatement costs since
sources with high costs can buy permits from sources
4
Article 4 of the Kyoto Protocol allows developed countries to
collectively attain their aggregate assigned amount of emissions, a socalled ‘‘bubble’’.
367
with low costs. This would also increase the number of
trades and lower transaction costs since fixed costs are
shared by more agents. Furthermore, the possibility for
a firm to exploit market power is reduced. A system that
allows for inter-source trading is more complex and
requires functioning domestic TEP systems in the
individual countries as well as functioning monitoring
and enforcement systems (Zhang and Nentjes, 1999).
3.2.1. Upstream and downstream TEP system
How then should domestic TEP systems be designed?
We can distinguish between an upstream and a downstream system. In a downstream system end-users are
required to hold permits, while in an upstream system
the incidence point is at either the extraction, processing
or transportation/distribution point in the fuel cycle. It
would not be efficient to include all end-users, such as
car owners, directly in a TEP system because of the high
transaction costs. In a report to the European Commission on a TEP system for greenhouse gases in the EU,
Helme et al. (2000) suggest that CO2 emissions from
energy use in larger power plants, refineries, and iron
and steel, inorganic chemical, cement and paper pulping
plants should be included in a downstream TEP system.
The other sectors should be covered in an upstream
system as described in Hargrave (1999). The upstream
system would require fuel producers/distributors to hold
permits for the potential CO2 emissions embodied in
their fuels. The distributors would then mark up the fuel
price, charging the end-users for the permit price. This
system would thus work very much like a CO2 tax,
although total emissions would still be known. Zhang
and Nentjes (1999) also propose that the permits should
be grandfathered to fuel-intensive sectors, while auctioned to fuel-extensive sectors and the fuel distributors.
The main reason for grandfathering to the fuel-intensive
sectors is to avoid political pressure against the
regulation. It is unclear whether domestic aviation
would be included among fuel-intensive sectors. Helme
et al. (2000) do not explicitly mention the aviation
sector, but they seem to imply that the whole transport
sector should be covered by the upstream system. In
principle, the aviation sector could be included in a
downstream system, while other transport sectors are
included in an upstream system. However, treating
different modes of transportation differently may turn
out to be problematic, since it could affect the
competitiveness between the modes.
A TEP for international aviation can also be of either
an upstream or a downstream type. However, in this
particular case the two systems are similar. There are
not enough number of participants to make transactions
costs too high, and monitoring and enforcement may
not be too costly in this type of system. Second,
monitoring and enforcement could actually be at the
upstream point. For example, fuel distributors may be
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F. Carlsson, H. Hammar / Journal of Air Transport Management 8 (2002) 365–372
responsible for holding permits when selling fuel to
carriers.
3.2.2. Lessons on distribution of permits
There are two systems for the initial distribution of
the permits for international aviation: a country-based
system and a carrier-based system. Gander and Helme
(1999) propose a carrier-based system, while Hewett and
Foley (2000) propose a country-based system. As
discussed by Hewett and Foley, it is not clear how a
carrier-based system could work in practice. The main
problem is monitoring and enforcement; in a countrybased system the individual countries would be responsible for the enforcement, while in a carrier-based system
an international body such as the ICAO would have to
be responsible. It is unclear whether it would be possible
for the ICAO to serve as a separate UNFCC party, or if
the airlines themselves could become parties. Furthermore, it is unclear what enforcement rights the ICAO
could have. Apart from this, the differences between the
two systems are small. In a country-based system the
permits would be distributed or auctioned to the air
carriers by the individual countries, while in a carrierbased system an international body such as the ICAO
would assume this responsibility. In the country-based
system, countries could apply different principles when
distributing the permits to the airlines. This could have a
discriminating effect, if for example some countries
distributed the permits at no cost, while other countries
sold the permits to the airlines.
The next step in the implementation of the permit
system would be to decide how to allocate the permits
among the carriers. There are essentially two systems:
auctions, where the EPA or, for example, the ICAO
auctions the permits to the individual sources, and
grandfathering, where firms receive the permits for free
based on historic emissions. The auction could be
revenue-neutral, where the revenues from the auction
would be distributed to the participants according to
some rule of distribution (Hahn and Noll, 1982).
Although grandfathering, or a revenue-neutral auction,
is more likely to be implemented for political reasons, it
may have problems that must be considered. First,
grandfathering can serve as a barrier to entry, since new
entrants must purchase permits from incumbent firms
(Stavins, 1998; Burtraw, 1999), and there is evidence
that grandfathering has slowed down the introduction
of new sources and new technologies (Nelson et al.,
1993). One way of reducing this effect would be to at
least auction a share of the permits. Second, grandfathering implies smaller incentives for adoption of new
and cleaner technology compared to a system in which
the permits are auctioned or to an emission tax (Fisher
et al., 1998). Third, the transaction costs of grandfathering permits to small sources may be high. Fourth,
in the case of transaction costs, the initial allocation of
permits affects the post-trading equilibrium resulting in
reduced trade and increased abatement costs (Stavins,
1995). Finally, there is recent literature showing, given
pre-existing tax distortions,5 important differences
between on the one side emission charges and auctioned
permits, and on the other side refunded emission
charges, revenue-neutral auctions and grandfathered
permits. Environmental regulations such as emission
taxes and emission permits increase the price of the
goods relative to leisure, which tends to compound the
distortions of the existing taxes in labor markets—a socalled tax-interaction effect (Parry, 1995). For example,
a carbon tax has a spillover effect on the labor market
since the tax tends to reduce the overall level of
economic activity and hence the demand for labor.
The distortions of a labor tax therefore increase because
of this spillover effect. This effect can be offset by a
revenue-recycling effect, which means that the distortionary taxes are lowered using the revenues from the
environmental regulation. By doing this the tax-interaction effect can, partly or completely, be offset by the
revenue-recycling effect. If the regulation does not result
in any revenues or if they are recycled to the regulated
industry, there will be no revenue-recycling effect.
Goulder et al. (1997, 1999) show that the revenuerecycling effect can indeed be important for the
efficiency effects of the regulation.
3.2.3. Heterogeneity of agents and policy implementation
One should not underestimate the political advantage
of a grandfathering system. In practice, the choice of a
policy instrument may be between grandfathered TEP
and a CAC regulation, and then a grandfathered TEP
scheme may still be preferred. We still believe that a
minimum requirement is that some of the permits are
auctioned, especially to reduce entry barrier problem of
grandfathering. An alternative is to auction all permits,
but refund the revenues to the airlines, much like the
refunding system of the environmental NOx charge in
.
Sweden (Sterner and Hoglund,
2000). This solution
would not be optimal, but it would at least reduce some
of the problems that arise from of a complete grandfathering of the permits.
The most reasonable definition of an emission permit
is that it is equivalent to a tonne of carbon, and that one
permit allows the use of a quantity of fuel that contains
a tonne of carbon. The cap for international aviation
should be set in accordance with international agreements. We see no particular reason for why international aviation should have a less strict regulation than
other sectors. After the initial allocation of permits,
airlines are allowed to trade them. An airline will buy
5
A labor tax, for example, is distortionary in the sense that it
increases the cost of labor relative to leisure and hence reduces the
demand for labor.
F. Carlsson, H. Hammar / Journal of Air Transport Management 8 (2002) 365–372
more permits if the price is lower than the marginal
abatement cost, and sell permits if the price is higher
than the marginal abatement cost. Airlines will thus
consider all possible alternatives for reducing emissions,
including more fuel-efficient engines, reduced number of
flights and increased ticket prices. Some of these
measures can easily be taken in the short-run, while
others such as investments in new aircrafts are long-run
effects of the regulation. If no trade between sectors is
allowed, total emissions will be equal to the cap. If trade
between sectors is allowed, total emissions can be higher
or lower than the cap, depending on the abatement costs
relative to other sectors.
The experience from the SO2 permit system in the US
is that flexibility in timing, in terms of banking permits
for future use, was an important factor in its performance (Stavins, 1998). Zhang and Nentjes (1999) also
argue that the permits should not be limited regarding in
which period or place they can be used. Since CO2 is a
uniformly mixed pollutant, restriction on the place does
not make sense. However, regarding timing, there may
be advantages in issuing time-restricted permits. In
particular, given a grandfathering of the permits, a timerestriction of the permits would reduce the barrier to
entry effect. Furthermore, the system can then more
easily handle future reductions in the total number of
permits. At the same time, there are efficiency gains of
having a flexible system with respect to timing.
3.3. An international aviation emission charge
An environmental charge in terms of a passenger
charge or a fuel charge would in general not be optimal,
since it would not provide direct incentives for reducing
the emissions. In the case of CO2 emissions, a fuel tax
would be optimal since the amount of CO2 emissions
only depends on the carbon content of the fuel type.6
However, other emissions such as NOx depend on
factors other than fuel use. Since higher combustion
temperatures tend to increase emissions of NOx,
increased fuel efficiency may while decreasing emissions
of CO2 and HC, increase emissions of NOx. In a socalled first-best setting, an optimal emission charge is
equal to the marginal damage cost of the emission. With
such a charge a firm would reduce its emissions until the
marginal abatement cost is equal to the marginal
damage of the emission.7 The emission/fuel charge
6
Note that due to international bunkering this must not necessarily
hold. However, if flights with at least one airport situated in an Annex
I country are bound to the Kyoto Protocol, international bunkering is
likely to be of minor concern (cf. Tsai and Petsonk, 2000).
7
A first-best setting assumes, for example, that there are no
distortionary taxes such as income taxes. Furthermore, the optimal
tax itself depends on the assumption made about the objective of the
regulation. In this case it is assumed that the objective is to minimize
total social cost.
369
Table 1
Estimated CO2 charge for different flights
Distance (km)
Load
Aircraft
Estimated cost
Charge per flight ($)
Charge per passenger ($)
500
67%
F50
Low
46.7
1.1
High
234
5.6
2000
67%
B747-400
Low
1429
2.6
High
7145
13.0
Source: Bleijenberg and Wit (1998).
should therefore ultimately be related to the marginal
damage cost of CO2 emissions. However, if the goal is to
reach a certain level of emission reduction, information
regarding abatement costs and price elasticities is
necessary. It would therefore be difficult to reach a
certain goal of emission reduction by means of an
emission charge. However, a regulator can iteratively
change the charge until the goal is reached, or initially
set the charge very high in order to reach the goal.
A large number of studies have estimated the
marginal damage cost of CO2 emissions. Barker and
Rosendahl (2000) estimate that a carbon tax of
approximately 150 ECU ($0.18/kg CO2) per ton of
CO2 is required for Western Europe to meet its Kyoto
targets. Bleijenberg and Wit (1998) use $0.02 and $0.10/
kg CO2 as the lower and upper bounds for the marginal
damage cost. Here we will use the estimates by
Bleijenberg and Wit for illustrating the effects of a
carbon charge on international aviation. These estimates
can be used when calculating the corresponding flight or
fuel charge; the two estimates correspond to a charge of
$0.06 and $0.316/kg fuel, respectively. Table 1 below
gives estimates for two specific flights reported in
Bleijenberg and Wit (1998).
For the B747-400 flight, the CO2 charge is equivalent
to 30% of existing airport charges for the low estimate,
and 140% for the high estimate of CO2 shadow prices.
Since the charge is directly linked to emissions,
airlines would consider all possible alternatives for
reducing emissions, including more fuel-efficient engines, reduced number of flights and increased ticket
prices. The decision on how to react to the environmental charge is a complex decision, but airlines would
generally try to reduce their CO2 emission for as the
marginal cost of the reduction is smaller than the
emission tax.
Bleijenberg and Wit (1998) is perhaps the most
comprehensive study on the potential impacts of
environmentally related charges on aviation. It focuses
on charges levied on pollutants emitted by aircrafts in
European airspace, but the conclusions that can be
made are more general. A number of options are
evaluated, the most relevant from our perspective being:
(i) an emission-based charge on pollutants emitted by an
aircraft in European airspace, with standardized charges
370
F. Carlsson, H. Hammar / Journal of Air Transport Management 8 (2002) 365–372
for routes and engines. Pollutants included are CO2,
NOx, SO2 and VOC. The revenues generated from
the charge are allocated to the EU, which distributes the
funds among the member nations. (ii) The same as the
first alternative, but the revenues are instead recycled to
the airlines based on the number of passengers- and
tonne-kilometers produced. (iii) A fuel charge package,
which consists of a fuel charge levied on bunkered fuel
and an emission-based landing charge on pollutants
emitted during the landing and take-off cycle. Further,
certain engine standards are implemented in order to
avoid increased NOx emissions.
The charge levels for these three options are estimated
to correspond to a fuel price increase of approximately
$0.20$/l (Bleijenberg and Wit, 1998), which is a dramatic
increase. If the airlines increased the fares correspondingly, fares would increase by $4 for a short one-way trip
and $10–15 for a long one-way European flight.
However, in the long-run, considering the development
of more fuel efficient and environmentally friendly
engines, the increase in ticket prices is estimated to be
approximately 25% lower than suggested above. Alamdari and Brewer (1994) investigated possible reactions to
an increased fuel tax on European airlines, by asking
airlines to assess their reactions to a fuel tax. They
discovered that the most likely reactions would be
increased fares, replacement of less fuel-efficient engines,
and cutting of costs in other areas of operations;
however, a reduction in the number of flights was not
one of the most likely reactions to an increased fuel tax.
Wit and Bleijenberg (1997) also found that the most
likely response, in the short-run, would be increased
ticket prices.
Given a demand price elasticity of 0.8 and a number
of assumptions regarding measures taken by airlines to
reduce the environmental impact, Bleijenberg and Wit
(1998) evaluate the environmental impact of the
different charge options. The charges are evaluated in
comparison to a 2025 business-as-usual scenario. In the
business-as-usual scenario, CO2 emissions are expected
to increase by 190% compared to the base year 1992.
With an emission charge of $0.2/l, the increase in
emissions would instead be 100% compared to the base
year. Consequently, even with a substantial increase in
fuel prices, CO2 emissions are expected to double by the
year 2025. The relative performances of the charge
options are similar, with alternative (ii) having a lower
impact due to the recycling of the revenues. The reason
why alternative (iii), the fuel charge, performs similar to
an emission-based charge is the assumption of the
accompanying emissions standards and an emissionbased LTO charge. The economic distortions of a
European fuel charge are expected to be relatively
minor according to Bleijenberg and Wit. For scheduled
carriers, it is expected that European-based carriers will,
compared to other carriers, face a smaller improvement
of economies of scale due to a reduction in the growth of
the market. In addition, Bleijenberg and Wit argue there
is a fundamental difference between the emission-based
charge and the fuel charge. Half of the fuel charge can
be avoided by an airline by shifting to an airport outside
the airspace of the charge, while the effect of such
behavior on the emission-based charge is minor since the
charge is based on emissions in the European airspace.
However, as discussed by Tsai and Petsonk (2000), it
may be sufficient that one of the airports is situated in
an Annex 1 country for total emissions to be covered by
the regulation. Airlines can still fuel at airports outside
the agreement and there may be incentives to locate
European hubs outside the agreement. Consequently,
compared to an emission-based charge, a fuel charge
discriminates airports that are within the agreement in
favor of airports outside the agreement, which would
most likely be airports on the eastern border of the
European Union.
The emphasis that the proceeds from the environmental regulation should be refunded to the aviation
sector, either directly or earmarked for reductions of the
environmental impact, is an understandable requirement. There are, however, several problems with
refunding, similar to the arguments against a grandfathering of emission permits. The incentives for
.
adoption of cleaner technology are reduced (Hoglund,
.
2000; Sterner and Hoglund,
2000), and if the number of
airlines is small, the incentives for emission reductions
will be reduced (Carlsson, 1999). Furthermore, in the
case of existing distortionary taxes, the tax interaction
effect (see Section 3.2) cannot be offset by a revenuerecycling effect.
3.4. A comparison of the instruments
With regard to international agreements, we believe
that an emission charge has one major disadvantage: the
difficulty of knowing the effect of the instrument on
total emissions. With an emission permit system, the
effect will be known, while an emission charge would
either have to be set very strict in order to ensure goal
achievement, or it would have to be changed iteratively.
If policymakers are risk-averse and do not wish to face
the situation of not fulfilling the international agreements, they may end up with a regulation that is too
strict. Clearly, there may be problems with fulfilling the
international agreements with TEPs also, for example if
a large share of the sources chooses not to comply with
the regulation.
If we disregard the desire to reach a certain level of
emission reduction, an emission charge is likely to be
preferred under uncertainty. It is reasonable to assume
that the marginal damage is essentially constant. This
means that if marginal abatement costs are uncertain, an
emission charge is preferred over emission permits
F. Carlsson, H. Hammar / Journal of Air Transport Management 8 (2002) 365–372
(Weitzman, 1974). The reason is that the optimal policy
depends on marginal abatement costs, and with an
emission charge the total abatement varies with the
marginal abatement costs. With TEPs, sources will
have to abate irrespective of the abatement costs, which
in the case of uncertainty can result in large losses. One
alternative would then be to use a hybrid policy
instrument. Roberts and Spence (1976) have suggested
combining TEP with an emissions charge and a subsidy.
In this hybrid system, sources are allowed to emit
without permits, but have to pay the emission charge.
Alternatively, sources can sell unused permits to the
regulator. Consequently, if abatement costs are higher
than what was expected, sources could opt for the
emission tax instead, and thereby reduce total abatement costs.
Other factors that affect the choice of policy instruments are: transaction costs, market structure and
political feasibility (Stavins, 1995). Transaction costs in
the permit market are important for performance.
Higher transaction costs tend to reduce trade and raise
permit prices; hence increasing total abatement costs.
TEP regulations are sensitive to strategic behavior and
can create barriers to entry. The success of a TEP thus
critically depends on the market structure.8 There are a
number of design issues for decreasing the possibility of
strategic behavior, such as auctioning of permits and not
grandfathering. Ironically, these design issues are also
important for the political feasibility. Grandfathered
permits are much more likely to be accepted by many of
the actors than auctioned permits or emission charges.
Finally, the importance of a functioning market with
small possibilities of strategic behavior, also directs the
attention to the benefits of allowing trading of permits
across sectors and countries if a TEP scheme is chosen.
Efficiency of the regulation increases with the number
and size of the permit market.
4. Conclusions
What general conclusion about an environmental
regulation can be made, given the premise that a
regulation of CO2 emissions from international aviation
is to be implemented? First, if possible to implement, an
IB regulation is likely to be preferred to CAC
regulations. Second, in practice the choice between an
emission charge and TEP is more dependent on
distributional and political considerations than efficiency considerations. An emission charge and a TEP
with auctioned permits have more or less the same
characteristics. The aviation sector is strongly opposed
8
Although it should be noted that optimal environmental charges
also depend on the market structure, see for example Simpson (1995)
and Carlsson (2002).
371
to environmental taxes on the grounds that environmental regulations should not have a fiscal motive. As
we have discussed, environmental regulations impose an
efficiency loss due to distortionary taxation, and therefore it may be important to use the revenues from the
regulation to lower the distortionary taxes.
There is no reason why the aviation sector should
have a less stringent regulation than other sectors,
so the cap or the charge should be set in accordance
with the international agreements. The most difficult
question with a TEP is how the permits should initially
be distributed. A grandfathering of the permits is
likely to have negative efficiency effects and it is
a positive discrimination of existing airlines. Grandfathering is also bound to create a discussion about
how the permits should be distributed. We would
therefore recommend an auctioning of the permits,
and not a grandfathering. Clearly, it would be important
that all countries involved in the regulation would
qapply the same type of distribution to the airlines.
Two possibilities that should be further investigated
are to refund the revenues back to the airlines
and earmarking the revenues to, for example, research
in more environmentally friendly engine technologies.
An additional design of the TEP that should be
considered is to allow for additional emissions at a
fixed emission charge level, or alternatively that an
additional number of permits are issued if the permit
price is higher than a predetermined level. This charge or
level could change over time. The advantage of such a
hybrid design is that the total abatement costs would be
known.
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